Next week offers quite a few trading opportunities.
Earnings are in full swing and quite a few large-cap stocks are due to announce.
So far, due to our patience in the selection process, this earnings season has allowed us to make several nice profits.
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My focus next week will be on a few of the bigger, lower-beta names like Mastercard (MA), Visa (V), Chevron (CVX) and a few others. Boring, low-beta stocks are always my preference. Remember, this isn’t a strategy that attempts to hit home runs. Singles and doubles are the goal coupled with strict risk-management guidelines, mostly seen through proper position size. The Netflixes of the world typically don’t make the cut, even though the premium can be appealing. Again, the law of large numbers determines our fate. So stay consistent and allow the statistics to work in your favor.
Here is an early look at a potential earnings trade for next week. Hopefully this helps a few of you with the mechanics of the trade.
Iron Condor Earnings Trade in Mastercard (MA)
Mastercard (MA) is due to announce before the open next Thursday. So, let’s take a look at a potential trade using a risk-defined options strategy like an iron condor.
The stock is currently trading for 360.14.
The next item is to look at Mastercard’s expected move for the expiration cycle that I’m interested in.
The expected move or expected range over the next seven days can be seen in the pale orange colored bar below. The expected move is from 343 to roughly 377.5, for a range of $34.50.
Knowing the expected range, I want to, in most cases, place the short call strike and short put strike of my iron condor outside of the expected range, in this case outside of 343 to 377.5.
This is my preference most of the time when using iron condors.
If we look at the call side of MA for the January 28, 2022 expiration, we can see that the 390 call strike offers an 90.61% probability of success and the 392.5 strike offers us a 92.25% probability of success. For this example, I’m going to sell the short call at the 390 call strike and define my risk with the 395 call strike. By choosing the 395 call strike to define my risk, I know that there is less than a 7% chance that I will take a max loss on the trade.
Now let us move to the put side. Same process as the call side. But now we want to find a suitable strike below the low side of our expected move, or 343. The 330 put strike, with an 86.39% probability of success, works as our short put strike. The 330 put strike defines our probability of success on the downside. I’m going to define my risk by choosing the 325 put strike with a 91.30% probability of success.
We can create a trade with a nice probability of success if Mastercard stays between our 60-point range, or between the 390 call strike and the 330 put strike. Our probability of success on the trade is 90.61% on the upside and 86.39% on the downside.
I like those odds.
Here is the trade:
Simultaneously:
Sell to open MA January 28, 2022 390 calls
Buy to open MA January 28, 2022 395 calls
Sell to open MA January 28, 2022 330 puts
Buy to open MA January 28, 2022 325 for roughly $0.75 or $75 per iron condor
Our potential return on the trade: 17.6%
Our margin requirement is $425 per iron condor.
Again, the goal of selling the MA iron condor is to have the underlying stock, in this case MA, stay below the 390 call strike and above the 330 put strike immediately after MA earnings are announced.
Here are the parameters for this trade:
- The Probability of Success – 90.61% (call side) and 86.39% (put side)
- The maximum return on the trade is the credit of $0.75, or $75 per iron condor
- Break-even level: 390.75 – 329.25
- The maximum loss on the trade is $425 per iron condor. Remember, we always adjust if necessary, and always stick to our stop-loss guidelines. Position size, as always, is key.
A Quick Comparison Between a Mastercard Iron Condor Earnings Announcement Trade and a Short Strangle Earnings Announcement Trade
As I have stated over the past few weeks, I would prefer to see a bit higher probability of success on the trade, but that is one of the downsides of iron condors versus, say, a short strangle. When using a risk-defined trade like an iron condor, as we increase our probability of success our potential premium declines.
For example, if we were using a short strangle, we could sell the 400 call strike and the 300 strike and bring in just as much as the iron condor example above.
The difference is an iron condor approach requires less capital and is risk-defined, therefore the percentage return is greater on the iron condor. But, the probabilities are significantly higher when using a short strangle and this is why professionals prefer strangles over iron condors, in most cases.
Again, it must be repeated, a short strangle does not have defined risk but offers a much higher probability of success. In this case, the probability of success if using a short strangle with the 400 call and 300 put strikes would be roughly 95.59% on the upside to 96.28% on the downside.
Out total premium would be roughly $85, slightly higher than the iron condor trade. And again, the probability on the short strangle is significantly higher.
That’s a big difference, and again, one of the reasons professionals tend to side with short strangles over iron condors. But remember, there is a time and place for iron condors. And if you want to define your risk, there really isn’t a better strategy to use around earnings.
Remember, I prefer to make these trades the day before earnings are announced, so I would expect to see the premium a bit lower than it is now due to decay. So, premium could be an issue at the time of the trade. But I like to see where potential trades stand the week prior, so I have a good understanding of what stocks look appealing for a potential trade around earnings, which is why I go through this exercise with the stocks on my weekly earnings watch list.
Again, if you have any questions, please feel free to email me or post your question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.